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Public Pension Funds Doubling Up to Catch Up?
Submitted by Leo Kolivakis, publisher of Pension Pulse.
Mary Williams Marsh of the NYT reports that Public Pension Funds Are Adding Risk to Raise Returns:
States
and companies have started investing very differently when it comes to
the billions of dollars they are safeguarding for workers’ retirement.
Companies
are quietly and gradually moving their pension funds out of stocks.
They want to reduce their investment risk and are buying more long-term
bonds.
But states and
other bodies of government are seeking higher returns for their pension
funds, to make up for ground lost in the last couple of years and to
pay all the benefits promised to present and future retirees. Higher
returns come with more risk.
“In effect, they’re going
to Las Vegas,” said Frederick E. Rowe, a Dallas investor and the former
chairman of the Texas Pension Review Board, which oversees public plans
in that state. “Double up to catch up.”
Though they generally
say that their strategies are aimed at diversification and are not
riskier, public pension funds are trying a wide range of investments:
commodity futures, junk bonds, foreign stocks, deeply discounted
mortgage-backed securities and margin investing. And some states that
previously shunned hedge funds are trying them now.
The Texas
teachers’ pension fund recently paid Chicago to receive a stream of
payments from the money going into the city’s parking meters in the
coming years. The deal gave Chicago an upfront payment that it could
use to help balance its budget. Alas, Chicago did not have enough money
to contribute to its own pension fund, which has been stung by real
estate deals that fizzled when the city lost out in the bidding for the
2016 Olympics.
A spokeswoman
for the Texas teachers’ fund said plan administrators believed that
such alternative investments were the likeliest way to earn 8 percent
average annual returns over time.
Pension funds rarely
trumpet their intentions, partly to keep other big investors from
trading against them. But some big corporations are unloading the
stocks that have dominated pension portfolios for decades. General
Motors, Hewlett-Packard, J. C. Penney, Boeing, Federal Express and
Ashland are among those that have been shifting significant amounts of
pension money out of stocks.
Other companies say they plan to
follow suit, though more slowly. A poll of pension funds conducted by
Pyramis Global Advisors last November found that more than half of
corporate funds were reducing the portion they invested in United
States equities.
Laggards
tend to be companies with big shortfalls in their pension funds. Those
moving the fastest are often mature companies with large pension funds,
and whofear a big bear market could decimate the funds and the
companies’ own finances.
“The larger the pension plan,
the lower-risk strategy you would like to employ,” said Andrew T. Ward,
the chief investment officer of Boeing, which shifted a big block of
pension money out of stocks in 2007. That helped cushion Boeing’s
pension fund against the big losses of 2008.
Shedding stocks
gave Boeing “material protection right when we needed it most,” Mr.
Ward said. By the time the markets had bottomed out last March,
Boeing’s pension fund had lost 14 percent of its value, while those of
its equity-laden peers had lost 25 to 30 percent, he said.
“We estimated that the strategy saved our company in the short term right around $4 or $5 billion of funded status,” he said.
Boeing and other companies seeking to reduce their investment risk are
moving into fixed-income instruments, like bonds — but not just any
bonds. They are buying and holding bonds scheduled to pay many years in
the future, when their retirees expect their money.
The
value of the bonds may fall in the meantime, just like the value of
stocks. But declining bond prices are not such a worry, because the
companies plan to hold the bonds for the accompanying interest payments
that will in turn go to retirees, not sell them in the interim.
Towers Watson, a big benefits consulting firm, surveyed senior
financial executives last year and found that two-thirds planned to
decrease the stock portion of their companies’ pension funds by the end
of 2010. They typically said their stock allocations would shrink by 10
percentage points.
“That’s 10 times the shift we might see in
any given year,” said Carl Hess, head of Towers Watson’s investment
consulting business. Economists have speculated that a truly seismic
shift in pension investing away from stocks could be a drag on the
market, but they say it would not be long-lasting.
Corporate
America’s change of heart is notable all on its own, after decades of
resistance to anything other than returns like those of the stock
markets. But it’s even more startling when compared with governments’
continued loyalty to stocks. When governments scale back on the
domestic stocks in their pension portfolios these days, it is often
just to make way for more foreign stocks or private equities, which are
not publicly traded.
Government pension plans cannot beef up
their bonds that mature many, many years from now without dashing their
business models. They use long-range estimates that presume high
investment returns will cover most of the cost of the benefits they
must pay. And that, they say, allows them to make smaller contributions
along the way.
Most have
been assuming their investments will pay 8 percent a year on average,
over the long term. This is based on an assumption that stocks will pay
9.5 percent on average, and bonds will pay about 5.75 percent, in
roughly a 60-40 mix.
(Corporate plans do their calculations differently, and for them, investment returns are a less important factor.)
The problem now is that bond rates have been low for years, and stocks
have been prone to such wild swings that a 60-40 mixture of stocks and
bonds is not paying 8 percent. Many public pension funds have been
averaging a little more than 3 percent a year for the last decade, so
they have fallen behind where their planning models say they should be.
A growing number of experts
say that governments need to lower the assumptions they make about
rates of return, to reflect today’s market conditions.
But plan officials say they cannot.
“Nobody wants to adjust the rate, because liabilities would explode,”
said Trent May, chief investment officer of Wyoming’s state pension
fund.
The $30 billion Colorado state pension fund is one of a
tiny number of government plans to disclose how much difference even a
slight change in its projected rate of return could make. Colorado has
been assuming its investments will earn 8.5 percent annually, on
average, and on that basis it reported a $17.9 billion shortfall in its
most recent annual report.
But
the state also disclosed what would happen if it lowered its investment
assumption just half a percentage point, to 8 percent. Though it might
be more likely to achieve that return, Colorado would earn less over
time on its investments. So at 8 percent, the plan’s shortfall would
actually jump to $21.4 billion. Contributions would need to increase to
keep pace.
Colorado cannot afford the contributions it
owes, even at the current estimated rate of return. It has fallen
behind by several billion dollars on its yearly contributions, and
after a bruising battle the legislature recently passed a bill reducing
retirees’ cost-of-living adjustment, to 2 percent, from 3.5 percent.
Public employees’ unions are threatening to sue to have the law
repealed.
If Colorado could somehow get 9 percent annual
returns from its investments, though, its pension shortfall would
shrink to a less daunting $15 billion, according to its annual report.
That explains why plan officials are looking everywhere for high-yielding investments.
Mr. May, in Wyoming, said many governments were “moving away from the
perceived safety and liquidity of the investment-grade market” and
investing money offshore, but he said he was aware of the risks.
“There’s a history of emerging markets kind of hitting the wall,” he
said.
Last year, the North Carolina Legislature enacted a
measure to let the state pension fund invest 5 percent of its assets in
“credit opportunities,” like junk bonds and asset-backed securities
from the Federal Reserve’s Term Asset-Backed Securities Loan Facility,
an emergency program created to thaw the frozen markets for such
securities.
The law also lets North Carolina put 5 percent of
its pension portfolio into commodities, real estate and other assets
that the state sees as hedges against inflation. A summary of the bill
issued by the state’s treasurer and sole pension trustee, Janet Cowell,
said it would provide “flexibility and the tools to increase portfolio
return and better manage risk.”
But some think they see new risks.
“It doesn’t pass the smell test,” said Edward Macheski, a retired money
manager living in North Carolina. “North Carolina’s assumption is 7.25
percent, and they haven’t matched it in 10 years.” He went to a recent
meeting of the state treasurer’s advisory board, armed with a list of
questions about the investment policy. But the board voted not to
permit any public discussion.
Wisconsin,
meanwhile, has become one of the first states to adopt an investment
strategy called “risk parity,” which involves borrowing extra money for
the pension portfolio and investing it in a type of Treasury bond that
will pay higher interest if inflation rises.
Officials
of the State of Wisconsin Investment Board declined to be interviewed
but provided written descriptions of risk parity. The records show that
Wisconsin wanted to reduce its exposure to the stock market, and
shifting money into the inflation-proof Treasury bonds would do that.
But Wisconsin also wanted to keep its assumed rate of return at 7.8
percent, and the Treasury bonds would not pay that much.
Wisconsin decided it could lower its equities but preserve its
assumption if it also added a significant amount of leverage to its
pension fund, by using a variety of derivative instruments, like swaps,
futures or repurchase agreements.
It decided to start with a
small amount of leverage and gradually increase it over time, but word
of even a baby step into derivatives elicited howls of protest from
around the state.
The big California pension fund, known as
Calpers, was already under fire for losing billions of dollars on
private equities and real estate in the last few years. So far it has
stayed with those asset classes, while negotiating lower fees and
writing off some of the most troubled real estate investments.
It announced in February that it had started looking into whether it
should lower its expected rate of investment return, now 7.75 percent a
year. It has embarked on a study, but a spokesman said that process
would not be done until December, safely after the coming election.
Politics
and public pensions - a deadly mix! When are these public pension plans
going to get it through their heads that 8% average annual return over
time is pure fantasy given where were are now? If inflation was
soaring, interest rates were above 20% and we had another Paul Volcker
as Fed Chairman, maybe this ludicrous "8% average annual return" would
be plausible.
But with the risks of deflation still high,
the Fed is desperately trying to reignite asset reflation hoping that
"contained inflation" will eventually materialize. If financial history
has taught us anything, it's that nothing is ever contained.
So
what are pensions to do? Private pensions are in no mood to crank up
the risk, but public pension funds are back to business as usual, and
even looking to leverage up to obtain their magic 8%. Many public plans, like OMERS, are still sticking to the motto that more private market assets will lead them out of their troubles.
They're in for a nasty surprise. Last January, I wrote that the alternatives nightmare continues, and I don't see it getting much better. In fact, as mighty endowment funds like the Harvard Management Company look to unload real estate and
other private equity holdings, private markets will likely suffer a long
drought, especially since public markets are not going to deliver
anything close to what they delivered in the last 30 years.
So what are public pension funds doing? Cranking up the risk, investing in failed banks, leveraging up, shoving more money in private equity and hedge funds, whatever it takes to achieve that insane 8% average annual return they're all still fixated on.
Any
idiot who has invested in markets knows that risk and return are
intimately related. Ideally, you want to achieve the highest possible
risk-adjusted returns, but this is not how most public pension funds
think. They just want to go about their merry way, trying to shoot the
lights out, taking increasingly stupider risks with pension monies -
money that is suppose to be invested prudently so workers can retire in
dignity and security.
On that last point, Reuters reports that Japan's public pension fund, the world's largest, has decided to not change its asset allocation model for the next five years after the Health Ministry urged the fund to keep investing in safe assets: The Its An An official at the GPIF declined to comment on the report, adding that We will see if Japan's sleeping giant awakens,
Government Pension Investment Fund holds assets of about $1.4 trillion,
larger than the gross domestic product of India, and is a major force
in financial markets, particularly the Japanese government bond market.
current model calls for a 67 percent weighting in domestic bonds, 11
percent in domestic stocks, 9 percent in foreign stocks and 8 percent
in foreign bonds.
official of the Health Ministry, which supervises the fund, said last
month the ministry hopes the current asset allocation model, which is
under review, would be the base for a new model.
its new allocation model will be announced before the start of the new
financial year in April after receiving approval from the ministry.
but the point is that unlike their US counterparts, Japanese are in no
hurry to crank up the risk and start tinkering with their asset
allocation. Given that they're still fighting a nasty deflationary episode, they
understand the value of bonds and are in no hurry to double up in an
uncertain environment. Their cautious approach might save them billions
- the same billions that US public plans will likely lose as they succumb to the ravages of casino capitalism.
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I'm self-employed and will not receive a pension, however; I've got a bad feeling I'm going to be contributing even though I'll never receive any of the benefits.
Why have we continued to trust these fools and thieves when we all know we can rarely trust ourselves to do the right thing consistently? What an abdication of our responsibility to ourselves and our families. Did we actually believe the "trusted financial advisors" were smarter than we are, and that they actually have our best interests at heart? Those smarmy commercials advocating we put our faith and life savings in the hands of these supposed professionals make me sick. From personal experience, I know how the money is made in that world and it's not pegged to the clients' financial security. The pension money has to be treated even worse - it's captive and impersonal with lack of accountability.
back of the envelope thoughts on the Wisconsin idea of levering up TIPS to achieve ~7.8%:
5yr TIPS yield 50bps, so they'd lever ~15x there, while 20yr TIPS yield 2.15%, so there they'd use a 4.3x gear...
TIPS are a nice inflation hedge, but currently they are pricing in 'real' yield (as they are 'risk-free', this is a proxy for growth or GDP) of 0.5% to 2% for year for the next 5-20yrs...
What if we see growth, ie GDP, but not the inflation? If growth picks up to 3-4% per year going forward, the 5yr TIP would trade closer to 4.0% and lose about 16% in price (x4.3, that's a 69% immediate, paper loss), while the 20yr TIP at 4.5% would lose 35% in price (x15 that's 525% immediate, paper loss)...
of course, they'd still have their levered 0.50% to 2.15% yields locked in, to dampen the blow... oh, and they are of course much smarter than me, so I must just be missing something.. oh yea, they are using derivatives, so I'm sure they are just 'derivatizing' away all the risk.... right? hello?
You need to remember that they are playing in a risk-free casino. At least they think they are. They are free to gamble to whatever extent is necessary. If they lose, the relevant governmental entity has to step in and make it so that the promised benefits get delivered. It's the law! It's heads-I-win-tails-you lose for the pensioners. the taxpayers get screwed, again.
At least until the governmental entity declares bankruptcy...
Leo,
I like to buy solar stocks, is this OK now??
That explains why plan officials are looking everywhere for high-yielding investments.<<<<<<
oh good grief. here we go again.....
Either they can double the money supply and induce mad inflation -
Or all these "retirement assets" blow up and the public realizes that Wall Street is nothing but a giant government-sanctioned scam.
"Sorry folks, but all that money you've been investing in stocks, bonds, real estate, pension funds, mutual funds, and insurance policies is gone. You got tricked fair and square, and now its time to move on."
- President Obama. December 2011
Leo,
But you used to say sveral times that equities will move up in the current QE environment. My feel is that you favor less risky assets, so you try to tell us that you like the fact that private pensions are positioning better for the future than public ones while at the same time in past notes you are predicting higher stock prices? Can you clarify your position a bit?
Much appreciated your time and efforts.
Chris
Chris,
The Fed is well aware of the pension problem. They're desperately trying to reflate assets, and create mild inflation. Remember pension deficits are all about asset-liability matching, so higher assets and lower liabilities (through higher discount rates) are what they're ultimately trying to achieve. But given the disaster in public pensions, it will take tough political decisions to fix this problem.
The term you are looking for is "double DOWN", what every degenerate gambler does when he is looking to compound his or her loss.
Given that public pension funds keep chasing performance, the term doubling up to catch up is most appropriate here (taken from the NYT article).
I am not an expert in this context, but I have read that [some proportion] of public funded public employee pension funds have commitments from the respective jurisdiction/municipality/district to cover any unfunded liabilities the pension fund may encounter. If and when true, the tax paying public appearts again to be backstopping speculation without their concurrent consent. If not true, please disabuse me of this notion.
I am not an expert in this context, but I have read that [some proportion] of public funded public employee pension funds have commitments from the respective jurisdiction/municipality/district to cover any unfunded liabilities the pension fund may encounter. If and when true, the tax paying public appearts again to be backstopping speculation without their concurrent consent. If not true, please disabuse me of this notion.
One large County in SoCal.....Riverside County, which includes Palm Springs, Rancho Mirage, etc.........is a classic example. The County's annual spending budget is currently $ 660 million. The County's unfunded pension obligation to CalPers is $ 600 million and growing.
And yes, the taxpayer is on the hook for shortfalls in the State and the local municipalities.....it's the " law ".
I wish I could.
Public pension obligations are backed by the full faith and credit of the municipality.
This is the most perfect definition of a PONZI scheme. EVERYBODY IN, pump those prices, now.......who gets to the exit first?
I'm self-employed and will not receive a pension, however; I've got a bad feeling I'm going to be contributing even though I'll never receive any of the benefits.
Get off the grid.
...but elsewhere we're reading that mutual fund cash holdings have never been lower. Is this already true with pension funds too? If so, and if the amount of cash available to bid up share prices is thus limited, what can they possibly hope for in the equity markets?
They're sunk, because...
a) Pension fund investments were predicated on annual returns which will not be seen in fixed income or, reliably, in stocks for many years to come;
and
b) To have any chance of even hitting a streak of luck in this game you have to be doing something that the others are NOT doing. That is you have to be a CONTRARIAN. Conservative, fixed-income oriented investors (like pension funds), who eschew even commodities, let alone gold, have the same future as the dinosaur.
It is never too late to catch up. But it would have been easier had they started at lower levels.
time123
Called the bottom: http://invetrics.com/?p=973
No, this is an orchestrated suicide.
I don't know whether its so the pensions can act as a giant garbage can, for the elite to throw their toxic crap into. Or whether it is simply to destroy one of the last remaining areas of wealth in the country to facilitate a new socialist system, such as the annuitized treasuries program.
But its not a few rogue fund managers gambling. The pensions have been hijacked outright.
It's both. Private corporations will own the state and citizens own nothing.
The US seems to be a country where you being mentally ill is a prerequisite to having a career and being successful. The mental illness is even celebrated and propagated around.
What a crap country.
I'm raising two young children and I can't help but notice that the age old lessons I'm trying to teach them, such as telling the truth and sharing, won't serve them well in this economy. I'm dooming them to poverty.
My goodness, that is actually a very interesting observation.
I would add to mentally ill, "demoralization and a spirit of servitude".
Death first for me.
lol, but true!